bizzXceleration: Performance, Value and Profit

Markets & Investments

S.E.C. Inquiry Looks for Conflicts in Credit Rating The Securities and Exchange Commission has opened an investigation into whether the credit-rating agencies improperly inflated their ratings of mortgage-backed securities because of possible conflicts of interest, the head of the commission told Congress on Wednesday. With the explosive growth in the market for mortgage-backed securities, the ratings agencies have come to play a central role in the housing market. After a homeowner gets a mortgage, the lending institution usually sells the loan to a Wall Street firm, known as an underwriter, where it is repackaged with other loans and sold to investors as a mortgage-backed security. Rating agencies grade those securities to let investors know the chances of default. As the subprime market has been rocked by a wave of mortgage defaults and worthless mortgage-backed securities, the rating agencies have come under renewed scrutiny by regulators and lawmakers.

Swap' in How Markets Work The credit crunch that swept through financial markets this summer surprised many investors. But some market jockeys who closely track a new breed of complex credit derivatives saw the meltdown coming ahead of time.

• Satyajit Das was discussed earlier on Mefi. This interview with him is a great explanation of the financial skullduggery that we're knee-deep in. Plunging into the shadows: "In thinly traded, lightly regulated and untransparent markets, the bold can make an awful lot of money—and they can lose it on an even more extravagant scale... In today's caffeine-fuelled dealing rooms, a barely regulated private-equity group could very well borrow money from syndicates of private lenders, including hedge funds, to spend on taking public companies private. At each stage, risks can be converted into securities, sliced up, repackaged, sold on and sliced up again. The endless opportunities to write contracts on underlying debt instruments explains why the outstanding value of credit-derivatives contracts has rocketed to $26 trillion—$9 trillion more than six months ago, and seven times as much as in 2003."
• U.S. Credit-Market Fallout `Likely to Be Protracted,' IMF Says in Report
• Jim Rogers Sees `Skyrocketing' Commodity Prices, Criticizes Fed Rate Cuts
• Syndicated Loans: Echoes of Subprime

·         World-Wide Financial Risk in a Single Picture The International Monetary Fund has produced a useful diagram of how its views of risks facing the world financial system have changed between its financial stability report of last April, and its latest, published this week. The diagram maps six different indicators of risk: emerging markets, credit, market and liquidity, risk appetite, monetary/financial, and macroeconomic risks. For a full explanation see the page 2 of the IMF’s Global Financial Stability Report

Goldman Sachs Sees `the Bottom' When Besieged Wall Street Can't Yet Concur Goldman Sachs Group Inc., the world's biggest and most profitable securities firm, has good news for its competitors: The worst credit-market shakeout since 1998 is abating. After winning its third-quarter bet against all forms of money devalued by the subprime mortgage collapse, while almost everyone else on Wall Street did the opposite, Goldman is signaling a turnabout. ``We are a lot closer to the bottom than where we were at the end of last quarter,'' Chief Financial Officer David Viniar said in an interview assessing the third-highest earnings in Goldman's history and the industry's only increase last quarter. ``There are going to be opportunities in the mortgage business,'' he said, and ``there are certainly going to be opportunities to buy distressed assets.'' The emergence of a bullish sensibility is resonating if only because so many of the New York-based firm's strategies have been on target. It was Goldman that foresaw this decade's bull market in fixed income and built a team of traders that generated a record $14.3 billion of revenue last year.

KKR's Banks Sell $9.4 Billion First Data Loans in Biggest Deal Since July Kohlberg Kravis Roberts & Co.'s banks sold $9.4 billion of loans used for the buyout of First Data Corp. in the biggest offering of high-yield debt since corporate funding dried up in July, according to a person with knowledge of the transaction. Buyers are starting to return to the market after record mortgage foreclosures prompted investors to shun all but the safest debt. Underwriters led by Citigroup Inc. and Credit Suisse Group had to offer a 3 to 4 percent discount to sell the First Data loans, and are still left holding as much as $14.6 billion more of the Greenwood Village, Colorado-based company's debt. Banks for First Data, the biggest processor of credit-card payments, cut the loan sale to $5 billion earlier this month because of a lack of demand. The six banks issued $7.6 billion of the debt at a discount of 4 percent of face value, the person said. A further $1.8 billion was sold at a 3 percent cut, said the person, who declined to be identified because details of the sale are private. Underwriters sold more than $7 billion of leveraged loans in the U.S. in the last two weeks, reducing their backlog of postponed debt offerings to about $370 billion, according to Bank of America Corp. Leveraged buyouts, which were at a record $613 billion in the first half of the year, slowed to $167.4 billion since then as banks stopped financing new deals, Bloomberg data show. Sales of U.S. leveraged loans declined to a total $12 billion so far this month from more than $50 billion in June, according to Standard & Poor's.

·         First Data: $9.4 Billion Sold Selling loans for 96 cents on the dollar is considered good news in this environment. Maybe Credit Suisse and Citigroup can sell more, and make up the loss with volume! The key number is the $14 billion or so in pier loans. The total deal value was $26 billion with $24 billion in debt. This is still larger than the Chrysler pier loans that were only $10 Billion.

Oaktree, BlackRock, Eaton Vance Plan Funds to Buy LBO Loans at a Discount Oaktree Capital Management LP, BlackRock Inc. and Eaton Vance Corp. are raising funds to purchase leveraged-buyout loans that banks are selling at a loss. At least 11 firms are seeking more than $12 billion as banks court buyers for more than $370 billion of debt they pledged to finance takeovers. Citigroup Inc., Credit Suisse Group and Deutsche Bank AG already have reduced prices on loans by as much as 4 percent to lure investors. Investment groups such as Los Angeles-based Oaktree Capital, which oversees $47 billion, and BlackRock in New York see a chance to profit because banks are stuck with loans they made before demand for below-investment-grade debt dried up in the past three months. The Standard & Poor's/LSTA Leveraged Loan Index fell 3.1 percent in July and August as record defaults on U.S. subprime mortgages drove investors away from all but the highest-rated securities.

Economy

Growth Recession Now, the Real Deal Tomorrow? On a year-over-year basis, growth in real gross domestic product (GDP) is settling in at around 2%. Although the economy’s precise potential growth rate is unknown, most estimates center around 2-3/4%. Therefore, it is safe to say that the economy currently is growing below its potential growth rate and is likely to continue so in the foreseeable future. This situation is sometimes referred to as a growth recession. As economic growth persists below potential, the unemployment rate begins edging higher and the manufacturing capacity utilization (operating) rate begins moving lower. What are the probabilities that this growth recession morphs into a full-fledged recession? The probabilities are high. In sum, the U.S. economy has entered, at best, a growth recession – an environment in which excess capacity will begin to rise in the labor and product markets. In turn, this excess capacity will temper price increases of good and services, and most likely equity prices, too. At worst, the U.S. economy is on the cusp of entering a full-fledged recession.

• Is this the start of Hamlet Act V?
• Greenspan Sees Greater Chances of U.S. Recession Now Than a Few Months Ago

·         Retailer Sales Fall 1 Percent in U.S., Prompting Cut in September Forecast, Lowe's and Target Warn

• Orders for Durable Goods in U.S. Decline 4.9 Percent, Most in Seven Months

European Economic Sentiment Drops to 16-Month Low as Inflation Accelerates European confidence in the economic outlook dropped to a 16-month low in September and inflation accelerated above the European Central Bank's ceiling as borrowing costs climbed and oil prices reached a record. An index of sentiment among executives and consumers in the 13 nations that use the euro fell to 107.1 from a revised 109.9 in August, the European Commission in Brussels said today. Economists forecast a decline to 109, according to the median of 30 forecasts in a Bloomberg survey. The data adds to evidence that fallout from the U.S. housing slump is spreading to Europe. The ECB, International Monetary Fund and European Commission have all cut forecasts for euro-area economic growth since surging credit costs curbed bank lending. Retail sales in Germany unexpectedly fell in August, the Federal Statistics Office said today.

·         Fed Paper: China Can’t Shield Asia From U.S. Slowdown

·         European Engine Might Stall New signs indicate that turmoil in global financial markets could hit the recovery in Europe's economy, one of the bright spots in the industrialized world. Recent surveys show that businesses in the 13-nation euro currency area are becoming sharply more downbeat. Worsening data are prompting economists to cut their growth forecasts for the region. A marked slowdown in the $11 trillion euro-zone economy would also harm the outlook for companies in Asia and the U.S., which have found unexpected sales growth and profits in Europe in the past year that have helped to offset weaker growth in the U.S.

·         German Business Confidence Declined to 19-Month Low in September, Ifo Says

Housing Chill Grows Worse Home resales tumbled 4.3% in August and a measure of homes on the market soared to an 18-year-high. The slump, along with credit-market turmoil, is beginning to hit retailers.  The housing market is going into a deeper chill, and consumers are starting to shiver.Sales of existing homes in August fell sharply, and home inventories by one measure soared to an 18-year high, according to data released yesterday. One major home builder, D.R. Horton Inc., is auctioning homes this weekend with starting prices for some units at 50% off an earlier price. The housing market is worrying consumers, raising fresh concerns about economic growth. Consumer confidence fell this month to its lowest level in almost two years, a new survey showed. Retailers such as Lowe's Cos. and Target Corp. said they're feeling the pain. Both reported softer-than-expected sales Monday. "The combination of all this is indicative of an economy that has lost quite a bit of momentum," said Joshua Shapiro, chief U.S. economist at the consulting firm MFR Inc., an economic forecasting firm that advises investors. Wall Street seems unconcerned for now. Broad stock indexes moved little yesterday, and the Dow Jones Industrial Average is just a few hundred points from its all-time high.

·         Lennar Reports $514 Million Loss, Biggest in Homebuilder's 53-Year History

• Home Prices Post Biggest Drop in 16 Years- The decline in U.S. home prices accelerated nationwide in July, posting the steepest drop in 16 years, according to the S&P/Case-Shiller home price index released Tuesday. [They Cried Wolf. They Were Right. ]

Subprime-Mortgage Defaults Rose Last Month, Data Show  Late payments and defaults among subprime mortgages packaged into bonds rose last month, according to data for loans underlying benchmark ABX derivative indexes. After August payments, 19.1 percent of loan balances in 20 deals from the second half of 2005 were at least 60 days late, in foreclosure, subject to borrower bankruptcy or backed by seized property, up from 17.5 percent a month earlier, according to a report yesterday from Wachovia Corp. Prepayment speeds for the loans slowed, suggesting it's more difficult for borrowers to sell their homes or refinance, according to another report by New York-based analysts at UBS AG. Record levels of delinquencies and defaults on subprime mortgages are worsening as home prices decline and interest rates on loans adjust higher for the first time. As lenders tighten standards, borrowers are finding it harder to refinance into new mortgages with lower payments. The ``reports showed the first inkling of the impact of shutdown of subprime market,'' the UBS analysts led by Thomas Zimmerman wrote late yesterday. ``In our opinion, the full impact is yet to come.''

Profit Growth in U.S. May Hit Five-Year Low as Housing Slump Curbs Demand Profit in the U.S. may grow at the slowest rate in more than five years this quarter as the housing slump hurts results at companies from IndyMac Bancorp Inc. to Target Corp. Earnings of Standard & Poor's 500 Index members may rise an average of 3.2 percent from a year earlier, breaking a 20- quarter streak of gains exceeding 10 percent, according to data compiled by Bloomberg. Since Aug. 20, at least 52 financial and consumer discretionary companies in the Standard & Poor's 500 Index have issued third- quarter forecasts that met or fell short of analysts' estimates, compared with 10 that said earnings would be higher than forecast.

Is Mishkin Mishuga* about Asymmetric Monetary Policy Responses? Why doesn’t the Fed want to act to prevent asset-price bubbles? Because it claims that it is not perceptive enough to identify these bubbles in their formation. Given the Fed’s dismal forecasting record of cyclical economic turning points, I take it at its word. Is there some alternative approach to the monetary policy operating procedures that would reduce the likelihood of the formation of asset-price bubbles without necessitating the Fed’s a priori identification of bubbles? Yes. Moreover, the approach I am about to suggest also would prevent rapid cumulative increases in the prices of goods and services, now commonly referred to as inflation. And my alternative approach would not prevent declines in the prices of goods and services that would occur “in nature” as a result of advances in productivity and technology.  What is this alternative Fed operating procedure? Have the Fed increase the amount of credit it creates at the rate of growth of the U.S. population. That is, keep the per capita dollar amount value of the Fed’s balance sheet constant. Chart 1 shows the actual per capita growth in the Fed’s balance sheet. From 1953 through 1960, the per capita change in the Fed’s balance sheet was negative. After 1960, with one exception, in 2000, the per capita change in the Fed’s balance sheet has been positive. From 1953 through 2006, the median annual percent change in the per capita value of the Fed’s balance sheet has been 4.5%.

Business

(***) Marked increase in health-care costs coming in 2008 A study shows that health-care cost increases are down to their lowest level in nearly a decade, but they're forecast to rise at a much faster rate again in 2008. The study from Hewitt Associates says that total health-care costs to employees will jump by double digits next year, and that point-of-service and-preferred-provider-organization coverage -- which have seen growth rates in the low single digits during 2007 -- will jump by a high-single-digit percentage. Those increases will more in line with health maintenance organizations and traditional indemnity plans. Hewitt researchers say that this year's price increase was artificially low since many employers have been socking away extra cash for health care of late. "In '06 and '05, employers were budgeting too much so they had overall surpluses in the plan," said Bob Tate, chief actuary for Hewitt's health-management consulting business. "They didn't have to budget so much [this year]." Tate adds, however, that insurers also will be upping their price increases by a percentage point or so, to about a 9% gain -- roughly triple the rate of inflation. Employers generally already have lined up their health-care plans for the coming year and are feeling the extra pinch.

Can the Washington Post survive? That's the story of the newspaper business right now. Alarmed by declining circulation, advertising and profits, America's newspaper publishers - as hidebound a collection of businesspeople as you can find - are thrashing about to see whether they can separate the news from the paper and still make money. They're going way beyond the headlines. No less a sage than Warren Buffett, a lifelong newspaper aficionado, the owner of the Buffalo News, and a director of the Washington Post Co. (Charts) for most of the past 35 years, told Fortune, "The present model - meaning print - isn't going to work." What lies ahead for the Post seems to be a long and painful transition from print - so important to local advertisers that the newspaper could raise prices almost at will - to the Internet, where competition for readers and advertisers is brutal. Between 1940 and 1990 about 267 papers shut down, victimized by big forces: TV news (which killed afternoon papers), the movement of people from cities to suburbs (which made delivery more costly), geographic mobility (rootless people tend not to read the local daily) and a decline in civic engagement dating back, as it happens, to Watergate. The Post's daily circulation peaked at 832,000 in 1993. It has dropped by nearly 20 percent since then, while the region's population has grown by about 20 percent. "I don't think any news organization has maximized the potential of the Internet," he says. "I know this one hasn't." Imagine if, when big news breaks, the Post's Web site routinely offered a print story, a video version, an audio point-counterpoint by op-ed columnists, maps, photos, links and reader reaction. Could washingtonpost.com become a leading online news destination?

Big Oil's Latest Roadblock Big Oil has a big problem. It may not be apparent from the huge profits that oil and gas companies are gushing. But the industry's future depends on its ability to rove the earth in search of new reservoirs of oil and gas. Yet as energy resources grow scarce, governments are restricting Western drillers' access to their fields. They're fostering their own champions, many of which are flush with capital, have learned from the majors and can easily contract drilling expertise from firms like Schlumberger, a Franco-American oil-services company. There at least three logical responses by the oil majors to the rise of National Oil Companies, or NOCs. The first, already under way, is to invest in countries where they're unlikely to see their assets expropriated. The second is to consider buying service firms themselves. Lastly, they could seek megamergers, along the lines of an Exxon-Chevron or BP-Shell, to counter the increasing heft of the NOCs.

·         BP's 'dreadful' quarter. New CEO says performance has been "dreadful," tells staff he'll undertake a major corporate revamp

Retailers may have worst holiday in five years, NRF says Amid housing concerns and credit worries, U.S. retailers could be headed for their worst holiday season in five years, according to the National Retail Federation. Holiday sales are projected to rise 4% to $474.5 billion, which would be the slowest gain since 2002 and would fall below a 10-year average rate of 4.8%, said NRF, the world's largest retail trade association. Target cuts sales forecast, analysts prune estimates

For Facebook, GeoCities Offers a Cautionary Tale Facebook founder Mark Zuckerberg was 10 years old when David Bohnett, then a 37-year-old mainframe programmer, hatched an idea: Set up a Web-based "community" where young people could divulge their most intimate feelings. He grouped those musings into different themes, and ushered in advertisers to hawk Volvos and Volkswagens. This ur-Facebook of 1994 was called GeoCities. And both its rise and fall are a history lesson for Mr. Zuckerberg as his social-networking site, the 16th-most visited on the planet, approaches its own crossroads: Should it sell, launch an initial public offering or take another investment round? GeoCities' tale shows just how necessary continual innovation -- and the capital to support it -- are for a Web media business. It's a lesson in the perils of being acquired. And yet it shows the value of humility, even in moments of the sweetest triumph. Just how many of the top 20 visited Web sites of August 2003 are still in that ranking? Nine. GeoCities grew popular before broadband, meaning that it would appear terribly crude to modern eyes. There was no video. It took hours to upload a photograph. Back then, entries were known as home pages, not profiles. But the basic, expressive elements of today's Facebook and competitor MySpace, owned by News Corp., were all right there. MySpace owner Rupert Murdoch, had it right when he summed up the state of 125-year-old Dow Jones & Co., publisher of The Wall Street Journal, which he is now buying. "The first road to freedom," he said of Dow Jones, "is viability."

Hiring Outside Talent, Microsoft Aims to Keep It That Microsoft granted his request illustrates a new approach Chief Executive Steve Ballmer is taking as he tries to expand the Redmond, Wash., company into new areas from online music to videogames to Internet advertising. Mr. Ballmer has found he must tap outsiders rather than rely so heavily on homegrown managers as in the past. How Microsoft fares with Mr. McAndrews will be a test for Mr. Ballmer, who has tried over the years to make the company a more hospitable place for outside talent. Another test will be Don Mattrick, whom Microsoft hired this summer to head its videogame group after a long career as a top executive at game giant Electronic Arts Inc. Mr. Ballmer has had some successes bringing in and keeping new executives, including Microsoft's current chief operating officer, Kevin Turner, plucked from Wal-Mart Stores Inc. two years ago, and finance head Chris Liddell, hired from International Paper Co. in April 2005. Still, a combination of forces within Microsoft -- its engineers' exalted stature, its insular culture, its sheer size -- make integrating new executives a lingering problem. Often through Microsoft's history, decisive and aggressive outsiders have been worn down by the second-guessing of Microsoft veterans before stepping down to less prominent roles or leaving altogether.

IBM to Help Businesses Better Compete Against Industry Rivals IBM (NYSE:IBM - News) today announced new industry-focused software and services to help clients spanning multiple industries including banking, telecom, healthcare and insurance, compete more effectively against competitors across the street, around the world or over the Internet. The new products help identify a client's performance against important business processes in their industry and then compare that performance to industry averages. IBM then helps develop a plan to increase a client's business performance, measure and track business goals and more effectively manage business processes across an organization to help clients become best in industry class. Specifically, today's announcement includes a Globally Integrated Enterprise Assessment, key agility indicators, business process management software and industry specific content.

Under pressure to deliver Alcatel-Lucent Chief Executive Patricia Russo has been given a month to devise an emergency restructuring plan for the board after the telecommunications-equipment giant issued its third profit warning under her leadership earlier this month, according to a media report. Alcatel-Lucent's board of directors has told Russo she must come up with a plan for further streamlining the company's organizational structure and present the information at the next board meeting on Oct. 30, French newspaper Les Echos reported on Friday. Per Lindberg, an analyst with Dresdner Kleinwort, on Thursday called for Alcatel-Lucent to replace Russo with Mike Quigley, the company's former chief operating officer, who quit last month. The analyst also estimated the company needs to pare 30,000 jobs, and not the 12,500 being targeted. His verdict on the merger is harsh. "There is little doubt that the merger between Alcatel and Lucent has turned into a veritable fiasco," he said.

Will Avaya Get Harmanized? KKR’s abandoning of Harman International Industries is causing separation anxiety for investors in other takeover targets like Avaya. Shares of Avaya plunged briefly this afternoon on suspicion from traders that Silver Lake Partners and TPG will abandon their buyout of the telecommunications-equipment company. (Coincidentally or not, at $8 billion, the deal is the same size as Harman.) Down as much as 11%, Avaya shares rebounded quickly after the company put out the word that the buyout is not in jeopardy. An Avaya spokesman told us the company plans to hold the shareholder vote on the deal Friday and expects it will close as planned at the end of October. (Although it could be the last to know if the buyout firms planned to bail.) Avaya stock closed with a loss of just 29 cents (at $16.50). It rose a bit more after hours too. But it’s no wonder investors are skittish. After being left at the altar, shares of Harman, the audio-equipment maker, are down nearly 30%. Investors in other companies with pending buyout deals are equally skittish. Shares of Guitar Center and Acxiom have dropped between 5% and 10% in the last two sessions. Shareholders in Sallie Mae parent SLM are on the edge of their seats too. Avaya’s shares have proved resilient in the past. They fell about 7.5% during the worst of the credit-market storm this summer, before rebounding on renewed hopes that the deal will survive the turmoil.